Anyone with children will tell you they are expensive and that expense only increases following separation where there is now the added burden of managing two separate households. Yet it is particularly following separation that parents feel pressured to maintain the lifestyle that their children were accustomed too prior to separation.
No one wants to tell their child that they now can’t play soccer, have piano lessons or go away on holidays because Mum and Dad have separated and they can’t afford it any more. For some people there is a solution that will help their money to go further. That solution is called a Child Maintenance Trust.
In most family trusts minor children who are beneficiaries are taxed at a rate of 47% for every dollar over $416 per annum. There is an exception however if you set up a Child Maintenance Trust. In a Child Maintenance Trust minor children are taxed the same way as adults and therefore have the same marginal rates and tax free thresholds. Let’s look at the difference below where, say, you wanted to pay $20,000 per annum to cover child support and school fees for each of your three children. What would be the difference if that income was coming out of your salary (disregarding that you have additional income at higher marginal rates) as opposed to income being paid out of a Child Maintenance Trust in distributions in the same amount:
|Salary||$60,000||Child Trust Maintenance Distributions||$60,000|
|LESS Tax on Salary||-$11,507||LESS Tax on Distribution||-$1,134|
Of course you would need to have sufficient assets or cash available to settle into the trust to ensure that there was sufficient income and capital to earn an income of $60,000 per annum. It allows parents to access the lower marginal tax rates of their children. It allows them to put aside property to ensure that their children are going to be looked after. As it is in a trust it won’t be subject to the risk that the payer’s income may fluctuate particularly if they are self-employed, and ensures there will be pool of funds available to ensure the children are looked after.
It also gives the parent who is normally the payee for child support certainty that child support won’t stop. It can also be useful where the payer might live overseas or have most of their assets overseas. For the payer it can give them some comfort that they will be able to see that the funds settled for the children are actually being spent for the benefit of the children.
There are some complex rules about how Child Maintenance Trusts are established to be able to take advantage of the generous tax treatment.
To establish a Child Maintenance Trust and vest income producing property in the Trust which would satisfy child support obligations:
- There must be a court order or an assessment or agreement under the child support laws which require a parent (or the parents) to pay support for the children.
- A parent or the parents transfer property to the Child Maintenance Trust to give effect to that legal obligation.
- The property transferred to the trust must ultimately vest in the child when the Trust ends. The Trust Deed establishing the Trust must make this provision.
- The Deed must provide that if the child dies before the trust ends the property must pass into the child’s estate.
- The trust must be used to contribute to the maintenance of the child beneficiary.
- The Deed must provide that the Trustee is able to apply the capital of the trust for the child’s benefit during the term of the trust, if in the Trustee’s discretion that is warranted.
- The child is to receive income from the investment of the trust property at no more than an arm’s length rate of return, however it is not necessary for the child to receive all of the income of the trust.
In simple terms you can reduce your taxable income by setting up a Child Maintenance Trust and transferring incoming producing assets into that trust.
The tax paid by the trust would be far less than the tax paid by the payer on the income which they earn in order to support their children. The savings can be quite substantial but the downside is that the payer would lose ownership of the income producing asset.
Child Maintenance Trusts are complicated but if you or your former spouse has an obligation to pay child support or you want to put arrangements in place to cover expenses in relation to your children they are worth considering.
At Farrar Gesini Dunn we are lucky to have lawyers with expertise in establishing Child Maintenance Trusts so give us a call.
Paul Salinas is a Family Lawyer and Superannuation Expert at Farrar Gesini Dunn, Canberra Office